Yen Rally Turns BOJ Rate Hike Into Takaichi’s Next Political Test

Prime Minister Sanae Takaichi, facing the Bank of Japan's September policy meeting, grapples with the yen's sharp rebound. The currency rose to a seven-month high against the dollar on September 8, prompting expectations of a BOJ rate hike by 25 basis points to 1.25%. This marks a reversal from July, when the yen fell to 40-year lows following a rare coordinated intervention by Japan and the United States to support the currency.

Finance Minister Satsuki Katayama affirmed Japan and the US's alignment on currency policy, emphasizing the government's stance remains unchanged. While a stronger yen can ease import-driven inflation, a rapid move could unsettle markets, particularly if it signals the unwinding of carry trades built around expectations that Japan would keep a low-rate economy.

The yen's recovery eases one of the clearest sources of household inflation but raises the cost of Takaichi's fiscal agenda, including food-tax relief and defense expansion. The September BOJ meeting is crucial, as a rate hike could prove Japan's commitment to controlling inflation but intensify scrutiny of Takaichi's fiscal promises.

Takaichi's advisers suggest the BOJ will raise rates in September and continue hiking at a pace of roughly once per quarter until January next year. The government must protect its fiscal policy from appearances of being corrected by the central bank, as any such perception could prompt opposition parties to challenge Takaichi's spending and tax-cut agenda.